Turmoil draws focus to 401(k)s

Q&A

The 401(k) retirement savings system has come under considerable scrutiny since the U.S. economic meltdown pushed stocks lower, costing retirement plans an estimated $2 trillion in the past 15 months.

A number of economists are calling for changes to the current 401(k) savings system. Some proposals wouldn’t affect workers much while others would force everyone to save and would have broad impact on the retirement planning industry.

Those who watch these things closely believe it’s unlikely that a complete overhaul will be seriously considered, and any reform is likely to wait until a new Congress convenes next year.

However, in light of the widespread concern that workers have lost large chunks of their retirement accounts, some changes may get serious consideration.

The House Committee on Education and Labor has heard from economists weighing in on both sides of the issue. Some defend the 401(k) as the best opportunity for workers to save for retirement at a time when companies are dumping defined benefit or traditional pensions, which guarantee retirees a specific monthly income for life.

The possibility of 401(k) reform is an important debate because the responsibility of managing retirement accounts has shifted dramatically from the employer to the worker. The number of individuals covered by defined-contribution plans increased from 18.9 million in 1980 to 52.2 million in 2004, the most recent year for which statistics are available. During the same period, the number of workers covered by a defined-benefit pension has fallen 30 percent from 30 million in 1980 to nearly 21 million in 2004.

This year even more companies may scale back their traditional pension plans because their investments have suffered steep losses in the market downturn.

Bad investment choices

Witnesses before the House committee, including University of Massachusetts professor Christian Weller and UCLA professor Shlomo Benartzi, stated that retirement security has been declining for several years because most people do not make good investment choices and are likely to pull money out of the market in turbulent times.

Jack VanDerhei, a Temple University professor and research director at the Employee Benefits Research Institute, said his recent studies show that 25 percent of workers who are within 10 years of their target retirement date had more than 90 percent of their 401(k) funds in stocks. About half of such workers had 70 percent invested in stocks.

Though no one size fits all, most investment advisers would recommend having significantly less in stocks that close to retirement. For instance, a 40 percent stake would provide greater stability because of the risk that too much could be lost in a volatile market.

Economics professor Teresa Ghilarducci, of the New School for Social Research in New York, said the current retirement system is leaving retirees without enough money, and poverty among the elderly will rise if nothing is done. “This will be the first time since World War II that the standard of living of elderly Americans declines while that of prime-age workers increases,” she said in a briefing paper for the Economic Policy Institute.

Alternatives suggested

In her House committee testimony, she proposed a plan in which workers would get a $600 tax refund but must set aside 5 percent of their pay into a retirement account managed by the Social Security Administration. The money would be invested in government bonds to earn at least 3 percent interest.

When they begin collecting Social Security, the retirement account would be converted to an annuity, providing a guaranteed monthly check for life. Combined with Social Security, the retirement account of a full-time worker with 40 years on the job retiring at 65 should provide 70 percent of preretirement income, Ghilarducci said.

Critics say the plan moves the nation away from a voluntary system to a mandatory government program, which has been rejected by lawmakers before. VanderHei points out that Ghilarducci’s plan would virtually scrap the current 401(k) system and lead to the destruction of the retirement planning industry in favor of a government-run program.

Chairman of the House committee, Rep. George Miller, D-Calif., has proposed changes more likely to be considered. They include: